Portugal announces 'enormous' tax rises

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Riot police stands in front of the Portuguese Parliament during a protest in Lisbon on September 15.

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Portugal announced sweeping new tax increases amid a powerful backlash

Move an effort to keep the country's faltering bailout programme on track

Lisbon would miss the budget deficit target by the equivalent of 1.1 percentage points

Portugal announced sweeping new tax increases in an effort to keep the country's faltering bailout programme on track amid a powerful public backlash against increased belt-tightening.

The new round of what the government described as "enormous" tax rises came as Lisbon revealed it would miss this year's recently relaxed budget deficit target by the equivalent of 1.1 percentage points if it failed to take exceptional measures.

Vítor Gaspar, finance minister, said on Wednesday these tax measures, including an additional 4 per cent levy on 2013 earnings, would replace a planned "fiscal devaluation" involving deep pay cuts, which the government withdrew following mass anti-austerity protests.

An unexpectedly strong backlash against austerity has fractured Portugal's mainstream consensus in support of deficit-reduction measures and highlighted the political difficulties facing eurozone governments struggling to implement increasingly tough fiscal reforms. The main trade unions immediately called a general strike for November 14 following Mr Gaspar's statement.

Despite fiscal struggles, Lisbon received encouragement from investors earlier on Wednesday, exchanging €3.75bn of government bonds due next year for longer-term debt.

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Mr Gaspar described the exchange as an unequivocal step towards regaining access to long-term debt markets within the coming year. He said it also moved Portugal closer to Ireland as a country that was making solid progress with its international bailout programme.

The bond exchange will reduce a €9.7bn debt redemption that falls due in September next year by about 39 per cent to €5.98bn, postponing part of the repayment until October 2015. Ireland has made similar exchanges in recent months to ease its way back into long-term debt markets.

Mr Gaspar said that Portugal had gained "precious time" through the exchange and shown that it could "finance itself at sustainable rates".

Nonetheless, some European officials have privately acknowledged that Lisbon's three-year rescue programme which is scheduled to end in mid-2014 may have to be extended by another year.

The new tax package will raise the average rate of income tax from 9.8 per cent to 11.8 per cent. New taxes on capital earning and homes worth more than €1m would also be introduced.

Mr Gaspar's announcement came shortly after government acknowledged that, without additional measures, the deficit would reach 6.1 per cent of output this year, above the new target of 5 per cent, which Portugal's international lenders agreed in September to relax from a previously agreed 4.5 per cent.

Most of the shortfall is to be recovered through the sale of a concession to run ANA-Aeroportos de Portugal, Portugal's state-owned airports authority, as well as cut backs in national contributions to EU aid schemes.

Lisbon's use of extraordinary measures to meet deficit targets for the second successive year reflects the "strong headwinds" that the EU and International Monetary Fund say Portugal is facing from the global economy.

After contracting an expected 3 per cent this year, the Portuguese economy is forecast to shrink a further 1 per cent in 2013, with unemployment climbing further above the current record level of almost 16 per cent.

However, using extraordinary revenue to meet deficit goals means Portugal will have to make a bigger adjustment than planned over the next two years to meet the 2.5 per cent of output target agreed for 2014.

In September, a planned social security reform triggered massive demonstrations and vehement opposition across the political spectrum

Pedro Passos Coellho, the prime minister, will face two censure motions in parliament on Thursday, tabled by small left-wing parties against his austerity measures. In addition, the centre-left Socialists, the main opposition party, plan to vote against the government's 2013 budget proposals in October.

Although the governing centre-right coalition is in no danger of being defeated over the censure motions or the budget, the prime minister's U-turn threatens to weaken the international confidence Portugal has gradually built up over the past year.

Moody's, the rating agency, this week said his "surrender" on social security was likely to encourage opposition to the adjustment programme and "create the expectation that protests can be successful again". This could prove "detrimental to market confidence".